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Minyan Mailbag: "Real Money"

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The problem the Fed has is that it can only control the supply of money...

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Professor,

Happy Thanksgiving.

Maybe the market action just reflects people's sense of 'entitlement' to a rising market. I don't think that everyone understands that they are being conned by the Federal Reserve with the liquidity driven global economy.

Vernon Smith's behavior finance studies concerning bubbles sure seem right on.

Best,

Minyan Ron

MR,

The Federal Reserve has already done 3 coupon passes in November totaling $3 billion. Remember, this is when they just call up a dealer and buy government bonds with printed (fake) money. The dealer then uses this "new money" to lend out to customers. This is unlike a repo because the supply of money is permanent.

The problem the Fed has is that it can only control the supply of money (I do not believe that they even control the price of money, or interest rates. I think the market does that, which is why short term rates have been rising). I look then at two components and call the combination "real money." The first - supply of money - we know is still rising, and rapidly. Thus, the coupon passes this month. The Fed controls this. The second - the velocity of money - we think is slowing rapidly. The Fed can make money available, but they cannot make banks lend it (they can cajole only) or consumers borrow it. So real money, real liquidity, has been dropping rapidly even though the Fed has kept the supply high because it is not getting lent out as much as it used to.

Perversely, this could be what is fueling higher stock prices and definitely what has fueled gold prices. The excess supply of money when not getting into the real economy (although the U.S. real economy is now inextricably linked to the stock and housing markets) fuels speculation. If we measure stock market rallies around the world in terms of gold instead of each currency, we find that the rallies are very small. We can then view the increase in nominal stock prices more as a drop in all currencies. Real wealth has not been created.

The by-product of all this is more debt and more imbalances. Ultimately they are untenable. But remember, nominal stock prices are fueled by sentiment and so far risk seeking behavior has increased into year end.

This is due to the above explanation and also year end trading by fund managers who take extra risk to improve portfolio returns.

Happy Thanksgiving to all,

Succo

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